Guest Commentary: Sanibel Captiva Trust provides current economic outlook
Just as we were getting comfortable with a “new normal” of lower growth potential following the “great recession” of 2008-2009 and an interest rate environment of “lower for longer,” along comes the surprise upset election of Donald Trump and the re-constituted Republican majorities in both the U.S. House of Representatives and U.S. Senate. The ripple effects of this tectonic shift in the U.S. and world economic order created more uncertainties. Investors are attempting to gauge which uncertainties will be positive for economic growth and asset values and which uncertainties will be negative.
The new “America First” agenda for the U.S. government seems to emphasize domestic production, international trade protectionism, increased military spending, lower taxes, higher spending on infrastructure, and political isolation. Taken as a package, these measures could lead to a shifting emphasis toward higher economic growth, higher fiscal deficits, and higher inflation and interest rates. Already, we are seeing the first signs of this changed outlook with improved consumer and business confidence – a likely precursor of higher economic growth as 2017 unfolds.
In addition, with the unemployment and inflation rates having met the stated goals of the Federal Reserve Board, short-term interest rates are on the rise. We expect at least two more increases of 0.25 percent in 2017 and as many as four increases of like amount in 2018. This would cause short-term rates to nearly double by the end of next year to 3 percent after staying near 0 percent for the previous eight years. Reversing the direction of interest rates could result in some friction developing between the head of the independent Federal Reserve and the politicians, impairing the central bank’s ability to properly manage the economy. This is just one more uncertainty to deal with.
We expect the transition going forward – a gradual tightening of monetary policy on the one hand; a meaningful easing of fiscal policy on the other to drive the real economy and asset pricing well into 2018. In addition, interest rates around most of the world now look to rise from the unusual negative rates that were experienced throughout 2016. After eight years of low interest rates and rising equity prices, we may see a reversal of these dominant trends this year. We are cautioning against too much exuberance as we are reminded of the axiom “Don’t fight the Fed.”
Given this outlook, we again are being careful about portfolio construction. While our clients own many wonderful companies in their portfolios, we are ever mindful that the valuations of many asset classes are closer to business cycle highs rather than lows. We look forward to the opportunity to add fixed-income securities to the mix as interest rates rise. We still expect moderate economic and profit growth around the world this year and next with relatively low inflation. Stabilization in both the value of the U.S. dollar and the price of oil will go far to act as a tailwind to profit growth this year after their negative effects in 2015 and 2016.
– Richard E. Pyle, CFA
President, The Sanibel Captiva Trust Company